On Inequality: Why Now?

Starting at the Economic Policy Institute in the early 1990s, I and others, like Larry Mishel, have been writing about growing inequality, trying to amplify and elevate the issue.

It now appears to be elevated. The CBO did an authoritative study of the US case, the OECD just followed up with an international version, and the newspapers and blogosphere resound with analysis and commentary.

Why now? Lots of good reasons.

Occupy Wall St: No one knows where this movement is headed or what kind of staying power it has. But like I said, I’ve been trying to elevate this discussion for decades and they’ve managed to do so in months. If you use (the very cool) Google trends, you can see a clear uptick in reporting on the issue coinciding with the rise of OWS.

Source: Google trends (HT: MB)

I hope the movement lasts and morphs into a progressive political force—a countervailing force of the type I discuss here. But if not, they already can take credit for starting a national conversation about the increasingly inequitable distribution of growth that stands as a profound economic problem in our country.

Piketty and Saez: By rigorously creating and, equally importantly, sharing with the world, a long time series of income shares going back the early 1900s, these researchers have provided extremely compelling evidence of how skewed the distribution of income has become in the other advanced economies. See here for recent CBPP work featuring P&S’s analysis (and here’s Saez’s website).

Here’s a picture from their work showing the share of income accruing to the top 1% since 1913. We’ve recently equaled highs in the inequality measure we haven’t seen since the late 1920s, and need I remind you, that didn’t end well.

[BTW, note the dip at the end of the series—2008 (these data are only available with a lag). That’s a cyclical dip, a function of realized capital losses from when the bubble burst, just like what happened in the last downturn. And as you can see, once the economy picked up again, inequality regained its momentum. I predict the same pattern in this expansion—see figure on the bottom of this post.]

Um…Inequality Itself and the Middle Class Squeeze: Look at that sharp trend in income share in the 2000s and consider that this trend occurred as middle class families were losing ground in terms of the their real income in those years, even while the economy expanded. They then got badly whacked in the Great Recession and are far from back on their feet. Meanwhile, though we don’t yet have the inequality data for recent years, we do know that corporate profits have more than recovered their prior peak while compensation as a share of GDP is at a fifty year low and real paychecks are falling.

For years now the economy has been growing yet most families are simply finding it a lot harder to get ahead than they thought, hoped, or remembered from earlier generations. Many of these folks are not prone to reading CBO and OECD studies, but when they hear about this stuff in this economic context, it resonates with them.

Perhaps if the growth of inequality were of a different nature—if families were generally all getting ahead but those at the top were getting ahead faster, as has been the case in some European countries, the issue wouldn’t be as resonant as it has been. But that’s not how it’s played out here.

Weaker Levees: Both the CBO and OECD studies find that the system of taxes and transfers has become less effective over time at pushing back on the rising tide of pretax income inequality.

From the OECD:

Tax and benefit systems play a major role in reducing market-driven inequality, but have become less effective at redistributing income since the mid-1990s. The main reason lies on the benefits side: benefits levels fell in nearly all OECD countries, eligibility rules were tightened to contain spending on social protection, and transfers to the poorest failed to keep pace with earnings growth.

As a result, the benefit system in most countries has become less effective in reducing inequalities over the past 15 years. Another factor has been a cut in top tax rates for high-earners.

Remember, and this is important as we move from diagnosis to prescription, the increase in inequality is very much a pretax phenomenon, and it’s neither realistic nor good policy to try to redistribute your way out of it. But you surely don’t want your tax and transfer systems to do less against that tide, to become less progressive, to exacerbate the market inequalities. Yet that’s the trend, and thankfully, that has caught people’s attention too. Just look at the polling numbers on the President’s call for measures like the expiration of the highend Bush tax cuts.

Of course, when I say people here, I don’t mean Congressional R’s along with the R candidates, who are busy agitating for bigger tax cuts for the rich and fighting tooth and nail against a 1.9% temporary surcharge on households above $1 million (0.2% of taxpayers; avg income $3 million).

I’ve got more for this list but I’d better go to work and see what we can do in the near term, most pressingly to get this payroll tax cut extension over the hump (and we’ve still got to work on UI too!).

7 comments in reply to "On Inequality: Why Now?"

One of my crazy hypotheses is that there is a dimension to inequality that is all about status. When tax rates are low as they are now, the status game becomes who can amass the greatest wealth. The Wall Streeters fight like starving wolves for another million because that is how you get status, not because they really need another million (and sure as hell not because they are trying to create jobs for the rest of us.)

Now jack up tax rates and you take all the fun out of the game, they are less likely to fight like crazy to take home another million. The game will change to what kind of an empire can you build, so they are more likely to invest in their enterprises than to suck the wealth out of them.

Of course, there are problems here also, more corporate authoritarianism, for one. So there also has to be a mechanism that increases pay for everyone else. If the desire to build the biggest company leads to high demand for labor, that may do. But I think we may need unions also.

Finally, I think there may be some anti-trust type things that can be done. Some vulture type vc’s who are active investors exercise their control in ways that screw workers. I am not sure how to counteract this.

Jared: I read you a lot and really enjoy your bog, but I hope you can clarify this passage in your post. “From the OECD: Tax and benefit systems play a major role in reducing market-driven inequality, but have become less effective at redistributing income since the mid-1990s. The main reason lies on the benefits side: benefits levels fell in nearly all OECD countries, eligibility rules were tightened to contain spending on social protection, and transfers to the poorest failed to keep pace with earnings growth.

As a result, the benefit system in most countries has become less effective in reducing inequalities over the past 15 years. Another factor has been a cut in top tax rates for high-earners.

Remember, and this is important as we move from diagnosis to prescription, the increase in inequality is very much a pretax phenomenon, and it’s neither realistic nor good policy to try to redistribute your way out of it. But you surely don’t want your tax and transfer systems to do less against that tide, to become less progressive, to exacerbate the market inequalities.”

Why do you write “the increase in inequality is very much a pretax phenomenon, and it’s neither realistic nor good policy to try to redistribute your way out of it.”

Why is it not realistic? Why is it not good policy? Cutting top marginal tax rates from 70% to 33% and cutting capital gains taxes, we appear to have redistributed wealth from the middle class up to the rich for 30 years using “good policy” that was “realistic”. Can you explain why the rise in inequality is a pretax phenomenon in America more thoroughly? Why is it not proper to reverse this maldistribution of wealth via the tax code?

Presently, there appears to be an efficient mechanism in place that’s redistributing wealth to the top 1%. Why not reverse it with all deliberate speed via the tax code, as a lack of revenues (the deficit) appears to be the main reason R’s and D’s want to cut the very benefits you see as a key element in fighting inequality?

That’s such a good question that I’ll do a post on it. But basically, we can, should, must use tax and safety net policies to pushback against the impact of higher inequality, but unless we change the primary distribution–market outcomes–we will be forced to depend every increasingly on redistribution and on Congress (!!?*&!*) to offset growing inequities.

It is difficult to “redistribute” because 1) It is too easy to paint the picture of the Welfare Queen to turn public opinion against any kind of direct transfer payments, and 2) once you tax to a certain level, people will try and avoid those taxes.

However, #2 is more important than people think. Think back to all those 1970’s movies about someone buying a money-losing business as a “tax writeoff”. In other words, a high tax rate can shift the economy so that efficiency matters less. Why is this important? Because inefficiency = more workers. Making a business more efficient usually means laying off people deemed to be not directly related to increasing profit. So a high tax rate can promote more hiring – less efficiency – because gaining efficiency is penalized and is less desirable.

In a perfectly efficient world, there would be a single company that does everything. They would hire the minimum number of employees to maximize their profits. They would have a single CEO, the minimal number of marketing people, the minimum number of accountants, etc. If they behaved nicely, this would be the most efficient means of producing the goods that people want. Problem is, this company would not – could not – employ everyone because it needs to deliver profits to its owners. Profits = money taken out of the system, that guarantees a deflation within the system.

We have to stop being so efficient. Wouldn’t it be a better economy if, instead of there being just 2 or 3 huge companies that made razor blades, there was instead 50 or 100 small companies (1 or 2 per state)? Sure, the blades would cost more money because their price would include “redundant” CEOs, marketing salaries, accounting staff, etc., but the number of people employed at each company would be higher and more distributed across the country. Additionally, with that many more people doing the work, the odds of innovation would increase.

The problem I see is that our business growth path has become too steep with national and then global markets. We go from 0 to 100 in a couple of years. Then there is no more room for a company to grow, so it starts consolidating to keep the profits coming. This cycle makes a small number of people very rich and keeps the rest of us in a constant state of concern.

I would submit that raising taxes by itself would partly address pre-tax incomes by affecting market outcomes. It seems to me that cutting capital gains taxes ought to increase capital gains. Since capital gains come from rising asset prices, cutting capital gains taxes ought to stimulate asset price growth, particularly in the most popular asset classes.

So when cap gains taxes were cut in 1997, when stocks were the most popular asset class, one should expect rising stock prices. And since stocks had already advanced 20% since Greenspan’s “Irrational Exuberance” speech, the result would be a stock market bubble. Thus, when Congress cut cap gains taxes in 1997 (as it had in the early 1920’s and 1980’s) I expected it to produce a stock market bubble and subsequent crash (as it did the two previous times) and stayed invested until 1999 (when my own valuation metric indicated record valuation). The expected bear market of 1997 did not materialized, instead we got a bubble and I did well.

Then in 2003 Congress cut capital gains taxes again. This time the popular asset class was real estate, which was fully-valued in 2003 just as stocks had been in 1997. History repeated and we got a bubble in real estate, the inevitable crash from which created the first financial panic in 75 years.

Since capital gains are still below the 20% trigger level, more bubble would be expected as soon as a popular asset class appears. Right now gold seems to be the one.

One can expand this concept by noting that higher taxes means less investable funds, which should translate to less demand for assets and so lower asset prices and a reduction in the supply of *new assets* like mortgage securities and CDO’s that were created to meet demand for assets caused by increased income flows recieved by teh very rich (who already have saturated their demand for goods/services)

So raise taxes and you “drain the swamp” reducing demand for assets, shrinking the financial sector, and reducing the financial character of our business, which I believe is a big part of our economic problem.